Though they operate in the same industry, Frontier Communications (NASDAQ: FTR) and Verizon Communications (NYSE: VZ) are two telecom companies of a very different nature.
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In fact, the past decade has seen Frontier's business model come under siege, while Verizon has largely strengthened its hand, even if it has underperformed the market averages over the past five years (before the effect of dividends).
However, this kind of backward-looking analysis doesn't necessarily say much about which company represents the better investment today. After all, contrarian stock picks can yield the best returns under the right circumstances. To get a better sense of which stock looks like the better buy today, let's analyze Frontier and Verizon in three important areas.
The telecom industry is well known for its heavy use of debt, and that trend holds true for both Verizon and Frontier. Here's a snapshot of four of the most important financial metrics to gauge a company's liquidity and solvency positions.
Data sources: Frontier Communications and Verizon investor relations, Yahoo! Finance. Click here to learn about the current ratio.
Although they operate at different scales, Verizon and Frontier share plenty in common in their capital structure and cash flow composition. Each company keeps between 2% and 3% of its debt allocation in liquid assets and maintains a ratio of debt to cash from operations of about 10-to-1. In fact, it's difficult to ascertain an advantage for either company in this section, so let's call it a tie and move on.
Image source: Getty Images.
Durable competitive advantage
When we look at their moats, the material differences between Verizon and Frontier really start to show.
Though Verizon provides Internet, cable, and landline phone services,the overwhelming majority of its subscribers and revenue come from its wireless telecom operations. As of its most recent earnings release, Verizon had 113 million pre-paid and post-paid wireless subscribers.Although the wireless market in the U.S. is reaching maturity, Verizon's shared place along with telecom giant AT&Tat the top of the U.S. telecom market gives it a powerful position from which to grow its business empire. For example, Verizon has delved deeper into content and mobile advertising with its recent acquisitions of AOL and ofYahoo!'s core Internet business. Both moves should help increase the company's average revenue per user even as subscriber growth slows.
On the other end of the spectrum, Frontier's business focuses on providing landline, TV, and internet packages to a small base of subscribers. As of its most recent earnings report, Frontier counted about 5.2 million consumer and business subscribers, down from about 5.4 million in the prior quarter.These are, in general, not growth businesses, but Frontier has done its best to position itself as one the strongest players in this space. Last year, for example, Frontier paid Verizon $8.6 billion to acquire customers in California, Texas, and Florida. The company's CEO, however, blamed merger-related issues for its recent customer defections, and while that could indeed be the case, the big-picture comparison is a no-brainer: Verizon is in every sense the stronger to the two companies here.
The differences in the quality of the two businesses shine through when considering their valuations. To that end, let's look at three of the most popular valuation metrics for Frontier and Verizon.
Data source: Yahoo! Finance. P/E = price-to-earnings ratio. EV = enterprise value. EBITDA = earnings before interest, taxes, depreciation, and amortization.
Though Frontier generated $1.6 billion in cash from operations over the past 12 months, it lost $373 million last year, its second straight year of GAAP losses.Its cash-flow-generation capabilities have increased year over year in each of the past two years, so Frontier doesn't appear to be facing an imminent demise. However, the company's business model is flying in the face of many of the telecom industry's long-term trends, and that shows with its valuation.
Verizon, on the other hand, is valued conservatively relative to the market, but that should come as no surprise, given the utility-like nature of the telecom business. For comparison, AT&T trades at 19 times past EPS and 13 times forward earnings,although its slightly higher valuation can also be attributed to its superior growth prospects versus Verizon.
And the winner is... Verizon
This contest was easy. Frontier has made some admirable moves to shore up its customer base in recent years, and these moves will benefit it in the years to come. Butthe long-term trends in the telecom industry could become too great for the company to overcome. Though Verizon could be more proactive in pursuing wireless video rights, the company's dominant position should allow it to remain one of the most powerful telecoms in the U.S., which makes Verizon the superior stock to buy today.
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